4 Most Used Budgeting Methods for Businesses

A budget is a crucial planning tool for every business. It estimates your future expenses, revenue, and profits. It helps you better control spending and identify situations where revenue may not be sufficient to cover expenditures. Moreover, a budget allows you to realize potential growth opportunities when you may have extra cash available to invest in new ventures.

This article will look into four different budgeting methods used widely among businesses and help you find the one that best suits your current situation and type of organization.

4 Types of budgeting methods: Which one is right for your business? 

Below are the most common types of budgeting methods that you may want to consider for your business.

Budgeting method #1: Incremental budgeting 

One of the most popular approaches is incremental budgeting. There’s no fixed formula for incremental budgeting – you simply change last year’s budget by an increment or percentage to obtain this year’s budget figure. 

This method focuses on small changes from the actual or budgeted results from the preceding period. It’s perfect when your primary cost-driving factors don’t regularly change. Without the need for complex calculations, incremental budgeting is the quickest of all budgeting methods. However, be aware that your company’s departments may overspend to avoid receiving a smaller budget the following fiscal year. It’s best to look into specific expenditures and spending habits to prevent any kinds of budgetary slack. 

Best for: Those who are limited on time but need a method that is  effective and reasonable. It’s also well-suited if you have an established business with predictable and consistent cash flow and financial activities. 

See also: How To Create a Business Budget with 7 Steps.

Budgeting method #2: Activity-based budgeting (ABB)

Activity-based budgeting (ABB) is a budgeting method in which every activity that incurs costs is tracked and analyzed to identify areas for improved cost-saving. After figuring out how to enhance cost-efficiency, a business will create a budget based on those findings. Companies typically employ this budgeting method to cut expenses, boost productivity, gain a competitive advantage, and improve overall operations efficiency. Rather than just using the past budgets to determine a new budget like the incremental budgeting method, the ABB system digs deeper into the company’s performance.

The ABB system gives you more control over the budgeting process. Since the budget uses relatively precise data for the projections, it helps managers align the budget with overall company goals much easier. Due to its complexity, the ABB method is more expensive and time-consuming to implement and maintain.

Best for: New companies without historical budgeting data should consider this method. The ABB method is also popular in major industries, like manufacturing, construction, and healthcare. Companies that are going under significant changes, such as new subsidiaries, large clients, business locations, or products, are likely to use the ABB technique as well.  

Budgeting method #3: Value proposition budgeting (VPB) 

Value proposition budgeting (VPB), or priority-based budgeting, is all about driving value. With this method, you go through every cost item to decide whether the value it brings justifies its cost. This allows your business to focus on true value drivers while avoiding wasteful spending. One of the main downsides of the VPB method is that value is not easy to determine as it depends on multiple factors like politics or economic trends. If there isn’t a clear understanding of value, business owners may make short-term decisions that negatively influence long-term goals. 

When preparing for the VPB method, businesses have to answer these essential questions:

  • Why are we spending this amount of money?
  • What value does it bring to our customers and stakeholders? 
  • Does the value outweigh the cost? 

Best for: This method best suits companies aiming to reduce unnecessary expenses and refocus on creating what customers want most. Many government entities also favor this budgeting method because it involves a lot of financial restructuring throughout the year, and VPB can help them identify which services are most valuable and most needed within the community.

See also: Are You Maximizing Your Business Budget?

Budgeting method #4: Zero-based budgeting (ZBB)

Zero-based budgeting (ZBB) is another common budgeting method. When applying the ZBB method, you assume that all department budgets are zero and must be rebuilt from scratch. In other words, past budgets’ numbers are not considered. Budget planners must justify every penny spent. The ZBB method is very strict, attempting to eliminate any expenses that do not contribute to the company’s profit. It’s difficult and time-consuming to carry out a zero-based budget, so many companies only use this approach on occasion.

Best for: This extreme budgeting method is very useful when a business has an urgent need to reduce cost, for example, a financial restructuring.  

The bottom line 

Employing a suitable budgeting method for your business is an effective way to save costs, increase productivity, and bring in more profits. 

By understanding the basics of commonly-used budgeting methods among businesses, you can gain a deeper insight into your own business’s situation to improve your financial performance. 

In order to determine your ideal budgeting method, it’s important that you have accurately recorded expenses. In order to do so, you need to have your receipts organized and stored safely.  

Shoeboxed can help you. 

Shoeboxed is a well-trusted tool to help businesses, freelancers, and DIY accountants store and organize their receipts. It is a software program that quickly and efficiently digitizes your receipts and documents. This app automatically extracts, verifies, and categorizes important data from your receipts, then stores them securely in the cloud. Most importantly, scanned documents from Shoeboxed are accepted by the IRS


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How To Create a Business Budget with 7 Steps

Once your business is up and running, it’s essential to manage your financial performance. Establishing a business budget is the most effective way to keep your business and your money on track.

Having a business budget lets you know how much money you have, how much you’ve spent, and how much you’ll need in the future. It also can drive important business decisions.

In this article, we’ll discuss what a business budget is, why it’s important to every business, and how to create a good budget for your company. 

What is a business budget?

A business budget is a detailed spending plan that outlines how you’ll spend your money monthly or annually based on your business income and expenses.

Every penny counts! So, if you want to make the most out of your business funds, a business budget is the perfect tool, as it allows you to compare your plan with reality to see how you did. 

A business budget will help you:

  • Determine your available capital
  • Forecast your spending
  • Predict revenue

Why is a business budget important?

Why is a business budget a must-have tool for every business? Simply put, a budget assists you in determining how much money you have, how much you need to spend, and how much you need to bring in to fulfill your business objectives.

More specifically, a business budget can help your business benefit by:

  • Identifying money that is available for reinvestment
  • Predicting slow months and keeping you out of debt
  • Estimating what it will take to become profitable
  • Providing a window into the future
  • Helping you keep control of the business

How should you create a business budget?

Now that we all acknowledge the importance of a business budget, it’s time to learn how to create a good one.

A budgeting process begins with a review of your previous revenue and spending as you get started. The longer you’ve been in business, the easier this process will be because you’ll have more data to work with when creating your forward-looking budget. However, suppose your company is fresh new; chances are you may need to conduct more in-depth research on average expenditures in your sector or area to develop workable estimates for your projected finances.

Every good budget should include seven components:

1. Estimated revenue

The first step in creating a business budget is to go backward and identify all of your revenue sources. To find out how much money comes into your company on a monthly basis, add all of those income streams together. When calculating your income, make sure you look at revenue rather than profit. 

Once you’ve identified all of your income streams, calculate your monthly income. It’s critical to do this over a period of months — preferably at least the previous 12 months if you have enough data.

2. Fixed costs

The second step is to identify all of your fixed costs. Fixed costs are expenses that remain constant throughout a particular period. They’re the expenses you have to pay whether or not your company operates. For example, due to the outbreak of Covid-19, many companies are being forced to shut down their operations temporarily. Though there are no operating activities, businesses still have to pay for fixed costs such as rent and interest charges.

Fixed costs within your business might include:

  • Rent
  • Supplies
  • Debt repayment
  • Payroll
  • Depreciation of assets
  • Taxes
  • Insurance

Every business is unique, so your fixed costs will differ from those listed above. Take a few minutes to make a list of any other fixed costs that your company may have.

3. Variable costs

While looking for the information you need to identify your fixed costs, you’ll notice that your company has some variable expenses as well. Variable costs fluctuate based on how often you use a service. Many of these, such as utilities, are required for your business to operate.

Some examples of variable expenses are:

  • Raw materials
  • Inventory
  • Direct labor costs
  • Equipment replacement 
  • Office supplies
  • Utilities

4. Periodic costs

As its name suggests, this type of cost doesn’t occur monthly or annually like fixed or variable expenses. However, there are some occasions that you’ll need these expenses, so you have to be aware of this and make a budget for them. Periodic costs include education expenses, networking expenses, travel expenses, etc

5. Cash flow

Cash flow is a metric that tells you the amount of cash that comes in or goes out of your business within a specific period. This metric also represents the amount of money produced or lost by a business during a given period.

Because cash flow is the oxygen of every business, make sure you keep track of it frequently. If you have a positive net cash flow, you’re likely on the right track. On the other hand, a negative net cash flow means you may need to reevaluate your strategies. 

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6. Profit

Profit is a business’s total revenue minus total costs, expenses, and taxes. If profits are increasing, your business is expanding. Based on your predicted income, costs, and cost of goods sold, you can estimate how much profit you’ll make.

If your profit margins (the gap between income and costs) aren’t where you’d like them to be, you should reconsider your cost of goods sold and consider boosting prices. Alternatively, if you believe you can’t squeeze any more profit margin from your company, consider increasing the Advertising and Promotions item in your budget to grow overall sales.

7. A budget calculator

When it comes to business budget planning, a budget calculator can help you know exactly where you are by compiling all of your budget’s figures into a single, easy-to-understand summary. 

Create a summary page in your spreadsheet with a row for each of the budget categories listed above. This is the foundation of your budget. Then write the total amount you’ve budgeted next to each category. Finally, add a new column on the right and record the actual amounts spent in each category at the end of the period. This gives you a quick snapshot of your budget without having to dig through layers of cluttered spreadsheets.

The bottom line

A budget is a road map for your business. Though it can be daunting and time-consuming, like any good habit or practice, you will see the positive results in just a month or so. Stay diligent and continue to reach out for guidance and informative articles to help you build a financially strong and healthy business with the Shoeboxed Blog

Shoeboxed is a cloud-based software that helps businesses turn their piles of paper receipts into digital data. With Shoeboxed, you can do tasks such as scan, store, and organize receipts, manage business expenses, and even track mileage for business travelers. It’s simple to install and easy to use. Try Shoeboxed today!

Are You Maximizing Your Business Budget?

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Every business owner wants to feel like they’re making the best decisions for their company. At no point do you want to look back over the past months or years and wonder what you could have done differently to prevent a bad situation. It’s much more gratifying to know you did everything you could for your business to ensure its growth.

One area many business owners have trouble with is their budget; namely, they have difficulty managing every cent that goes out the door for necessary expenses. It does take money to make money, sure, but it doesn’t always take the amount you’re shelling out every month. Certain expenses could be shaved off while others could actually stand to be increased.

It all depends on if your current budget is moving your business forward like it should be. If not, it’s time to move some things around the place. Let’s take a look at some problem areas you may want to fix. Continue reading “Are You Maximizing Your Business Budget?”